What is Discount Yield?
398 reads · Last updated: December 5, 2024
The discount yield is a way of calculating a bond's return when it is sold at a discount to its face value, expressed as a percentage. Discount yield is commonly used to calculate the yield on municipal notes, commercial paper and treasury bills sold at a discount.
Definition
Discount yield is a method for calculating the yield of a bond, particularly when the bond is sold at a price below its face value. It is expressed as a percentage and is commonly used for municipal notes, commercial paper, and Treasury bills sold at a discount.
Origin
The concept of discount yield originated with the development of the bond market, especially as governments and corporations began issuing short-term debt instruments. As financial markets became more complex, investors needed a way to assess the actual yield of discount bonds, leading to the widespread use of discount yield.
Categories and Features
Discount yield is primarily applied to short-term debt instruments such as municipal notes, commercial paper, and Treasury bills. These instruments are typically sold at a discount, meaning their purchase price is below their face value. The calculation of discount yield considers the purchase price, face value, and time to maturity, providing a straightforward way to compare yields of different bonds. Its advantage lies in its simplicity, while its disadvantage is that it does not account for the reinvestment of interest.
Case Studies
Case 1: A municipal note is sold for $950 with a face value of $1000 and a maturity of one year. The discount yield is (1000-950)/950 = 5.26%. Case 2: A company's commercial paper is sold for $980 with a face value of $1000 and a maturity of six months. The discount yield is (1000-980)/980 = 2.04%. These cases demonstrate how discount yield can be used to evaluate the yield of short-term debt instruments.
Common Issues
Investors often confuse discount yield with yield to maturity. Discount yield does not consider the reinvestment of interest, whereas yield to maturity does. Additionally, discount yield is suitable for short-term debt instruments and not for long-term bonds.
